What Is a Note Receivable? Definition and Examples

A note receivable represents a formal, legally enforceable claim held by a business or individual to receive money from another party at a future date. It typically arises when immediate cash payment isn’t made, requiring a structured repayment plan. It signifies an asset, indicating future economic benefits for the holder. Unlike informal promises, a note receivable is backed by a written agreement, establishing clear terms for repayment and providing certainty regarding collection.

Understanding Notes Receivable

A note receivable is a written, unconditional promise by one party (the maker) to pay a sum of money to another party (the payee) on demand or at a specified future date. This formal documentation lends legal weight to the promise, making it more secure than a verbal agreement. Companies often use notes receivable when extending credit to customers, especially for larger amounts or longer repayment periods.

Notes receivable differ from accounts receivable. Accounts receivable are informal, short-term amounts owed by customers, typically arising from regular sales on credit, and usually do not bear interest. In contrast, notes receivable are formalized by a promissory note, a legally binding document. They often include interest and typically involve longer payment terms, sometimes extending beyond a single business cycle. This formality and interest provide the payee with greater assurance of repayment and compensation for the extended period.

Key Elements of a Note Receivable

A note receivable is structured around several essential components defining the agreement. The “principal amount” refers to the original sum borrowed or owed, representing the face value of the note. The “interest rate” specifies the percentage charged on this principal, compensating the payee for the use of their funds. This interest is typically calculated over the life of the note.

The “maturity date” is the specific date when the principal amount and any accrued interest are due. The “maker,” also known as the debtor, is the party who promises to pay and signs the note. Conversely, the “payee,” or creditor, is the party to whom payment is promised and who holds the note. The “date of issue” marks when the note was created and the agreement became effective. These elements collectively establish the legal and financial framework for repayment.

How Notes Receivable Are Created

Notes receivable typically arise from business transactions requiring formal repayment. One common scenario is when a business or individual lends money and requires a structured repayment plan beyond informal credit. For instance, an employee cash advance might be formalized with a promissory note.

Another instance occurs when a customer needs more time to pay for goods or services than standard credit terms allow. Instead of extending informal credit, a business might issue a note receivable to formalize the extended payment period, often with interest. Businesses also create notes receivable when selling significant assets, like land or equipment, and accept a note as payment, which may include installment terms. An overdue accounts receivable can also be converted into a formal note receivable, giving the debtor more time to pay while formalizing the debt and potentially adding interest.

Financial Statement Impact

Notes receivable are recognized on a company’s financial statements as assets, representing money owed to the business. On the balance sheet, classification depends on maturity. Notes due within one year are current assets, reflecting short-term liquidity.

Notes due beyond one year are listed as non-current or long-term assets. This distinction helps users assess a company’s short-term liquidity and long-term financial position. Any interest earned on notes receivable is recognized as revenue on the income statement, contributing to the company’s profitability. This reflects the economic benefit from extending credit.